The Intelligent Investor Ch. 6: Portfolio Policy — Stocks, Bonds, and Rebalancing

"The investor should maintain a definite proportion between stocks and bonds and adhere to it through market fluctuations. The value of the rule lies precisely in the discomfort it causes." — Benjamin Graham

Investment Context

Graham's portfolio policy is so simple it is often mistaken for outdated: keep equities between 25% and 75% at all times, with the balance in high-grade bonds, rebalancing periodically to the target.

The elegance lies not in the numbers but in the fact that it constrains extreme behavior in both directions.

The Wall Street Translation

1. What Each Bound Prevents

• The 75% ceiling: Stops you from going all-in out of greed late in a bull market.
• The 25% floor: Stops you from abandoning equities entirely out of fear after a crash — typically the worst possible moment.

The key insight: most investors' severe errors are not poor security selection but pushing allocation to extremes at extreme moments. The bounds exist to make the worst decision structurally impossible to execute.

2. The Mechanical Logic of Rebalancing

Suppose the target is 60% equities and 40% bonds. After a strong rally, equities reach 72%:

| Action | What you actually did | |---|---| | Sell 12% of equities, buy bonds | Trimmed near a high | | Market later falls; equities drop to 48% | | | Sell bonds, buy equities | Added near a low |

Rebalancing forces the correct but counterinstinctive action — it converts "buy low, sell high" from a slogan into a step triggered automatically by arithmetic.

3. Rebalancing Is Not a Return Enhancer

One misconception is worth correcting: rebalancing primarily controls risk rather than raising returns. Across long stretches where equities outperform, rebalancing slightly reduces total return.

Its real value is preventing the portfolio from drifting, unnoticed, to a risk level far beyond your tolerance. A 60/40 left alone for a decade may quietly become 80/20 — and you would discover it only in the next crash.

4. Policy Must Be Written Before Emotion

Graham stressed that the allocation must be decided and recorded while markets are calm. Allocation decisions made in the middle of violent moves are almost always wrong, because fear or greed is driving rather than analysis.

This is the same principle as Principles Chapter 3 on this site: move judgment out of the moment of maximum emotion into the moment of maximum calm.

Actionable Trading Rules

1. Write down your target and bounds: Set the stock/bond ratio while calm, plus the drift threshold that triggers rebalancing — typically five percentage points.
2. Rebalance by rule, not by forecast: Execute when the trigger is hit; do not defer because "it feels like it will keep rising."
3. Never breach the bounds: However exciting or frightening markets become, do not let equities exceed 75% or fall below 25%.